Why learning to see the layers of money will reveal the politics of 'cashless society', and much more
thank you for this very useful metaphor, which I have been using in some of my contexts before but not in this clarity and depth.
You describe banks‘ superpower to "issue Layer 2 chips to borrowers, in exchange for a loan agreement in which the customer promises to return a larger amount of Layer 1 money to them in future than what the chips promise to them now (in a sense, the bank ‘buys’ a higher-value long-term promise by issuing lower-value short-term promises, but exposes itself to risk in the process)."
In this paragraph an important point is missing: In most cases, for any loan agreement / credit creation banks additionally request bankable securities, some form of non-monetary assets that back up their risk in case of a loan default. Layer 2 chips issued by the banking sector are therefore i.e. mostly asset backed tokens (merely pretending to be savers‘ money, as you correctly argue).
For Layer 3 Tokens, legal compliance regarding their actual backing varies broadly.
Thanks for this, Brett. I was in Portland, Oregon recently and I noticed that several businesses had “cash-free establishment” signs in their windows. In some cases I thought these were like “driver carries no cash” (i.e. don’t rob us) signs, or that they were (more likely) “dollar bills are germ-delivery-systems, so we don’t touch those anymore” signs (mild pandemic virtue-signaling), but now I wonder: do banks offer incentives to small businesses to go cashless? Or maybe the pandemic has done that work for them.
There's a few things missing from this viewpoint.
Cash is a receipt for a bank liability. In the UK a bank note is nothing more than a receipt for central bank created liabilities in the Issue Department of the Bank of England. That's it. The system is already cashless - it became that as soon as the ability to convert the notes into silver or gold coins was removed. Cash is really just a bank transfer to and from the Issue Department.
The Issue department of the Bank of England maintains balancing assets with the National Loans Fund - directly via the Ways and Means Account and Gilt issue and indirectly via the Bank of England Banking department which similarly holds Gilts as balancing assets.
The National Loans Fund has balancing item asset with the Consolidated Fund, and the Consolidated Fund holds the ultimate asset - the ability of Parliament to obtain tax from people in the denomination everybody is using. The whole of the Sterling system is a layered discounting of that power.
There's a layer 0, layer -1, and layer -2 before you reach the root of the system.
See "An Accounting Model of the UK Exchequer" for the gory details.
You may also want to explore why the liabilities in the layers are exchangeable 1-for-1 with the other layers for a particular denomination, but not between denominations. That's to do with the contractual basis of the relationship - in the UK's case the Sterling Monetary Framework which constrains a bank to behave in a particular way and subject itself to regulation, in return for the state guaranteeing that the liabilities they issue will be (largely) money good.
The banks, in effect, have become agents of the state in return for stopping the liabilities they issue from floating in value against each other.
As of 2020, the Federal Reserve lowered reserve requirements to ZERO. And in Canada too. That means banks can now issue money without being required to back it by L1 money.
Those trillions “printed” and given out to people as PPP loans were originated by banks. But the loan forgiveness comes from where? Who pays the liabilities these banks have to each other?
Technically, the banks can simply cancel liabilities they have to each other. If Bank A issues a loan or credit card and it is redeemed for credits in Bank B, while Bank B does the same for bank A, then the banks can simply cancel out their debt to each other when they settle their balances periodically using the Automated Clearing House (ACH) system that is also run by the Federal Reserve.
So banks can issue a ton of money to spur economic activity, and then cancel the debts to each other and take it out of circulation.
Intercoin.org is about making an alternative to the banking system, allowing cities and other communities to issue their own currency (eg Berkshares, Bristol Pounds etc.), give it out as a UBI and then tax it back to remove money from circulation (fiscal policy). The fiscal policy can then be used to mitigate negative externalities like pollution etc. So the monetary and fiscal policies are managed by the people. The businesses are getting money from people spending money on things they actually want, rather thank bank underwriters trying to guess whether there will be a lot of demand for the business’s services 5 years later.
Very illuminating and clear. Thanks Brett! Carne Ross
Do you assume that all kind of loans are digital? What about when a client ask for a cash loan? The money have to be back to its physical form again.
I live in Iraq, a cash dependent society. How your metaphor applies in this case?
Thanks for article, can't stop sharing it with my network.
Great metaphor and exposition! But how does it map to the M0-M3 taxonomy from college macroeconomics? All the explanations I've ever come across are so abstract I'm unsure.
Thanks, enlightening as always!
I like your casino-chip metaphor. The biggest reason that this layering framework does not get popularized, in my opinion, is that making the distinction (between layers) that truly exists raises the cost of understanding but do not yield immediately visible value for many people. In other words, incorrect understanding does not directly impact those people who misunderstand (somehow every person in the monetary system shares the aggregate cost of misunderstanding). So, even though i enjoy and agree about this layering framework, I strongly believe many people would still and continually treat those money from different layers simply as different forms of money.
Very interesting, and a useful metaphor. I tried in the past to explain everything with the general mechanism of loan/IOU. Banks and central banks are only special players among many, including consumers and corporations. But that's very abstract for many people.
Thank you this is really useful. I'm wondering, could reserves be considered another, distinct layer (layer 0)?
Whenever I read about a country running out of dollars, I think why don't they just get an American bank to lend them dollars (since the bank can create them from nothing)? Is it because they need reserve dollars (layer 0), and banks can only lend them layer 1 or 2?
Sorry if it's a dumb question I'm not an economist